What is a Cryptocurrency Exchange & How it Works

One of the best ways to acquire Bitcoin is by exchanging USD or another fiat currency for BTC. The most common place where people buy BTC with fiat currencies is a Bitcoin exchange. Today there is a wide range of crypto exchanges to choose from and each one is slightly different from the next.

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What is a cryptocurrency exchange?

A Bitcoin exchange is a digital platform where people can buy, sell and transfer Bitcoin or other cryptocurrencies. Simply put, Bitcoin exchanges are merely companies which websites facilitate the secure transfer of fiat or digital currency to BTC and vice-versa. They are intermediaries between their customers and make a profit by collecting fees.

The example of such an exchange is Coinbase that allow you to buy, sell and trade Bitcoin at any time using traditional fiat payment options. In return for providing you with a secure platform where you can not only exchange Bitcoin but also store it, Coinbase charges small fees on most transactions.

How does a crypto exchange work?

The working principle of a cryptocurrency exchange is similar to a stock exchange. The perpetually moving price of Bitcoin is tracked and sales are executed in real time based on the live market price.

People looking to sell Bitcoins specify the amount and the price they’d like to sell them at. All those requests, known as ‘orders’, are placed in a common ledger, called the ‘order book.’

When another person wants to buy Bitcoins, they either look for a satisfactory offer in the order book or, if none can be found, create their own ‘buy order’, specifying the terms of the deal as they like. Whenever possible, the exchange matches buy and sell orders by price and processes the trades.

Now, Bitcoin transactions can take a long time - from five to 10 minutes at the least, and up to several hours. Fiat money transfers usually take even longer; in some cases, international payments may take several days to complete. In order to speed up the process of trading, the exchange serves as a trusted intermediary: it settles all trades immediately, even though the actual transactions might have not yet been finished.

Besides, on a site like Coinbase, by simply typing in the amount of Bitcoin you would like to purchase and choosing a method of payment, you can quickly and easily boost your Bitcoin wallet.

Advantages of Cryptocurrency Exchanges

Variety of Cryptocurrencies

A cryptocurrency exchange is variable as it trades in multiple digital coins, meaning you can take advantage of price variations in different currencies and make money. There are hundreds of cryptocurrencies and exchanges that offer you an opportunity to either buy or sell multiple cryptocurrencies for profit. Without exchanges, this would be impossible.

Secure purchase

Most of the crypto exchanges have an escrow system where the sellers’ coins are held until the buyer sends the payment which guarantees the seller’s and the buyer’s security throughout the purchase process. Without this system that exchanges provide, it would be impossible for cryptocurrency trade to take place. That’s because there would be no way for buyers and sellers to guarantee each other’s transaction security.

For instance, imagine having some bitcoins that you want to liquidate for cash. Without an exchange, you would have to advertise those coins on the internet with no guarantees that the buyers will send money once you give them your bitcoins. This is one of the fundamental cryptocurrency problems that exchanges have solved.

Liquidity provision

Liquidity provision makes it easy for people to trade their Crypto’s. Without an exchange, you will unlikely to sell your crypto coins to anyone. However, using crypto exchange you are always assured that there is someone on the other side waiting to buy your coins, provided you are selling them at the prevailing market rates.

ICO opportunity

One of the best ways to make money through cryptocurrencies is to buy into new ones during an ICO, and then sell them once their price surges.

Disadvantages of exchanges

Vulnerability to hackers

It’s no secret that anything that makes good money attracts fraudsters and all sorts of criminals. In the last one year, cryptocurrencies have raked in billions of dollars as more people look to them as an alternative investment vehicle. As a result, many exchanges out there have become susceptible to hackers. For example, Bitfinex and Coincheck, the largest crypto exchanges in the world were hacked, and people lost millions worth of Crypto. Though many exchanges have invested heavily in security, there is always that risk of losing all your coins in case of a successful hacking attempt.

They are conduits for pump and dump schemes

Yes, it's great you can buy a new cryptocurrency during its ICO. However, the ICO can be a pump and dump scheme in the end. A pump and dump scheme simply means that a group of fraudsters come up with a new coin that has little inherent value, then push it through exchanges. As people take interest in such a coin, they sell their stakes and leave investors holding worthless coins.

What to look out for before putting money in an exchange

To make the best out of an exchange, look out for the following:

Compare exchange fees

To make the most out of an exchange, choose the one with low fees. Before you commit money in any exchange, compare fees on two or three exchanges then make a decision.

Deposit and withdrawal limits

Some exchanges have a limit as to how much money you are going to sell or buy. The best exchanges are those with no deposit and withdrawal limits, especially if you have a large sum of money. However, if the sum is small, then you may consider other factors like fees and the security capacity of an exchange.

Check out online reviews

Most times reviews don’t lie. To safeguard your money, it would be best to go for an exchange that has a good online reputation. Anything with mixed or negative reviews could be a recipe for disaster. You might end up losing your money to hackers if the said exchange has poor security, or you might have your coins frozen on flimsy grounds.

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